What is Passive Income?

By Ryan J. Taylor

Personal finance gurus are always talking about how in order to truly become financially free, you must have enough passive income to exceed your expenses. That’s great, but what is passive income and how do you get it?

In its simplest form, income can be broken down into four categories: earned income, portfolio income, leveraged income, and passive income.

  • Earned income, as you probably figured, is income that requires you to show up to get paid. Money is earned from your individual time and energy. This is how most people earn their living – as an employee.
  • Portfolio income is the interest, dividends and capital gains that comes from the ownership of stocks, bonds and mutual funds.
  • Leveraged income is created when one activity earns more money with larger captured audiences. A speaker at a conference, for example, may largely put in as much effort to arrange and give a speech to 20 people as 1,000 people, but can earn much more money with the larger group.
  • Passive income is income that requires an upfront investment and keeps paying over and over while the required involvement dissipates. The initial effort creates a cash machine that brings money in many times over, though the participation becomes minimal.

As you can tell from above, earned income only pays you what you put in. In other words, it requires your time and. You can earn raises and promotions, but your income is limited because there is only one of you.

With passive income, on the other hand, you can create multiple streams of income that continues to bring in money long after you did the work once. As you continue to add more and more cash generating machines, your passive income streams increase along with your wealth.

Let’s look at a few examples so we can get started making passive income streams.

  • Cash Flow Positive Real Estate: Passive income can be generated from residential or commercial properties. Real estate is what most people think of when it comes to passive income. But, it’s only passive income when the rent you receive is greater than your mortgage, taxes, maintenance and expenses. Otherwise, your rental property is just a liability that costs you money – not makes you money. If this is the case with you, you are probably speculating to make money off the appreciation.
  • License a Patent: Got a great idea or an invention? License it and get paid anytime anyone uses your licensed patent.
  • Become an Author: Copyrighting materials that earns royalties, such as books or e-books, music or lyrics, and photos or images, is another way entrepreneurs create passive income.
  • Automated Fulfillment Websites: Build an e-commerce site that can effectively process and fill orders with little involvement in order to produce some passive income.
  • Pay for Use Items: Vending machines, quarter car, coin laundries, washes, video arcades and storage units can all earn passive income.
  • Build a Successful Business: A successful business in these terms means a business that can run with or without your heavy involvement. How often, for example, do you see the owner of a McDonald’s franchise on location? A franchise that is cash flow positive and has a team to run the business is earning passive income for the owner.

Realize that passive income does not necessarily mean that there is no involvement on your end. Creating passive income streams often involves a large investment up-front, but in the end it requires little or no interaction.

Also, just because you make an earned income now (opposed to a passive income) does not mean you should quit you day job and open up a quarter car wash. To start building passive income streams you will likely need to keep making an earned income in order to convert that income into passive income by purchasing rental properties, etc.

Once your passive income is greater than your expenses, you can make the decision to stop making an earned income and live the rest of your life financially free.

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